chapter 11 part a income taxation of individuals deductions for agi itemized deductions fall 2007 n.
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Chapter 11-Part A Income Taxation of Individuals. Deductions For AGI Itemized Deductions Fall, 2007. In 2007, Mr. and Ms. Jones have combined salaries of $60,000.

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In 2007, Mr. and Ms. Jones have combined salaries of $60,000.

Their only expenditures affecting the tax return are state income taxes of $6,000, mortgage interest of $5,000 and real estate taxes amounting to $1,000.

They have two small children whom they support, and file a joint return.

What is their taxable income for 2007?

deductions for agi
Deductions For AGI
  • Discussed in previous chapters
    • Retirement plan contributions including IRAs
    • Moving expenses
    • 50% of self-employment taxes
    • Self-employed health insurance
    • Alimony paid
deductions for agi1
Deductions For AGI
  • Deductions discussed in this chapter
    • Educator expenses
    • Student loan interest expense
    • Tuition and fees deduction
    • Health savings accounts
    • Penalty on early withdrawals of savings
    • Other deductions for AGI
educator expenses
Educator Expenses
  • Kindergarten through 12th grade teachers may deduct up to $250 of unreimbursed expenses for books, supplies, computer equipment, software, and other supplemental materials used in the classroom
student loan interest 1
Student Loan Interest-1
  • Deduction allowed for interest paid on qualified student loans incurred and used for tuition, fees, room, board, books, and supplies.
student loan interest 2
Student Loan Interest-2
  • Deduction limit is $2,500
    • Limit is phased out for modified AGI of $55,000 - $70,000 ($110,000 - $140,000 for married persons filing jointly)
student loan interest 21
Student Loan Interest-2
  • Individuals claimed as dependents cannot take deduction on their own tax return.
  • Expenses paid by tax-exempt scholarships or subject to education credits must be excluded from loan amounts and related interest.

HW-19 Student Loan InterestCecilia is married and files a joint return with her husband, Steve. They have modified AGI of $120,000. Cecilia paid $2,700 in student loan interest this year. What is her interest deduction?

tuition fees deduction 1
Tuition & Fees Deduction-1
  • $4,000 deduction for 2005 for tuition & fees for taxpayer, spouse, and dependents
    • Income limits apply ($65,000 if single and $130,000 if married filing jointly)
tuition fees deduction 2
Tuition & Fees Deduction-2
  • Deduction reduced to $2,000 for singles with AGI $65,000 - $80,000 ($130,000 - $160,000 for joint filers)
    • Individuals who are claimed as dependents cannot take deduction on their own tax return
    • No double benefit - no deduction if expense is deductible under any other provision (including education credits)
health savings accounts
Health Savings Accounts
  • Taxpayers covered by high-deductible medical insurance policies only may deduct amounts set aside in an HSA
  • Contributions and earnings on HSAs are not taxed when withdrawn to pay medical expenses
    • Distributions not spent on qualifying expenses are included in income and subject to a 10% penalty
health savings accounts1
Health Savings Accounts
  • To qualify for an HSA in 2006, individuals must have health insurance with deductibles of at least $1,100 ($2,200 for families)
  • Maximum contribution to HSA equal to lesser of $2,850 ($5,650 for families) or the annual policy deductible.
medical savings accounts
Medical Savings Accounts
  • MSAs are similar to HSAs but with different limits
    • Qualified policies are those with deductibles beteen $1,900 and $2,850 for individuals ($3,750 and $5,650 for families) in 2007
    • Contributions to MSAs are limited to 65% of policy deductible for individuals (75% for families)
    • Distributions not spent on qualifying expenses are included in income and subject to a 15% penalty

HW-20 Health Savings AccountsAshley is single and owns a sole proprietorship. She pays $2,600 for high-deductible medical policy for herself --with a $2,300 deductible. How much can she set aside in an HSA?


HWA-20 Health Savings AccountsThe maximum Ashley can contribute to an HSA for 2007 is $2,850 ($3,650 if 55 or over).She can deduct the $2,850 for AGI if contributed to an HSA. She can deduct the $2,600 medical insurance premium only if she itemizes.

penalty on early withdrawals
Penalty on Early Withdrawals
  • Penalties assessed on premature withdrawals from certificates of deposits or other savings accounts are deductible
    • Gross interest income, unreduced by the penalty, is included in taxable income
    • Deducting the penalty ensures that only net interest income is included in taxable income
special travel deduction
Special Travel Deduction
  • For nonreimbursed travel expenses to attend National Guard or military reserve meetings more than 100 miles from home
  • Maximum deduction is general government per diem rate for the area
    • Excess expenses can be deducted as miscellaneous itemized deductions (subject to 2% of AGI floor)
special travel deduction1
Special Travel Deduction
  • Expenses of fee-basis government officials
  • Expenses of performing artists
  • Each taxpayer (who is not a dependent) is entitled to one personal exemption
  • Exemption deduction is $3,400 for 2007
  • Additional exemptions allowed for each person who is considered a dependent
    • Anyone who is claimed as a dependent cannot claim a personal exemption
    • For purposes of the dependency exemption, a dependent is a qualifying child or qualifying relative
qualifying child
Qualifying Child

Must meet four tests

  • Residency test - live with taxpayer more than 6 months
  • Relationship test - son, daughter, brother, sister, or descendant
  • Age test - under 19 (or under 24 if full-time student)
  • Support test - child cannot provide more than half his own support
qualifying relative
Qualifying Relative

If not a qualifying child, then three similar tests must be met:

  • Relationship test - must either be a qualifying relative of the taxpayer or a resident in the taxpayer’s household for the entire year
  • Gross income test - the qualifying relative's gross income from taxable sources must be less than the exemption amount ($3,400 for 2007)
  • Support test (provided by taxpayer)
qualifying relative support test
Qualifying Relative Support Test
  • Taxpayer must provide more than 50% of the dependent's total support
    • Support includes amounts spent for food, clothing, shelter, medical care, education and capital expenditures such as a car
    • Value of services and scholarship funds are omitted in determining support received by a student
    • Dependent’s nontaxable income used for support must be included in support determination

HW-20 Dependency Exemptions-1Joseph provides $12,000 of support for his mother, Miriam, who lives in his house. Miriam is a U.S. citizen and single. Miriam’s only income is Social Security of $5,000 and taxable pension income of $4,000. Miriam uses the Social Security income for support but puts all of the pension income into her savings account.


HW-21 Dependency Exemptions-2Joseph also provides $6,000 of support for his 22-year-old son, Mike, who is a full-time student attending college on a basketball scholarship. The balance of Mike’s support comes from a scholarship that pays Mike's $10,000 tuition and fees for the year. How many dependents can Joseph claim on his tax return?


HWA-21 Dependency ExemptionsOne. Miriam’s taxable income ($4,000) is above the allowable $3,400 limit so she does not pass the gross income test. Mike is a qualifying child so he qualifies as a dependent.

multiple support agreement
Multiple Support Agreement
  • Multiple support agreements allow one member of group of support providers to claim the exemption when
    • Together the group meets the support test
    • All other dependency tests are met
    • Member who claims exemption must provide more than 10% of the total support and other members providing more than 10% support agree to exemption
phaseout of exemptions
Phaseout of Exemptions
  • Both personal and dependency exemptions are phased out at a rate of 2% (4% for MFS) for each $2,500 (or fraction thereof) of AGI above thresholds for 2007 of
    • $156,400 if single
    • $195,500 if head of household
    • $234,600 if married filing jointly
    • $117,300 if married filing separately
exemption phaseout
Exemption Phaseout
  • (AGI – threshold AGI)/$2,500 = Phaseout Factor (always round up to next whole number)
  • Phaseout Factor x 2 = Phaseout Percentage
  • Phaseout Percentage x Exemption Amount x 2/3 = Exemption Reduction
  • Exemption Amount – Exemption Reduction = Allowable Exemption Deduction
    • Once AGI exceeds the threshold AGI by more than $122,500 ($61,250 for MFS), only 1/3 of exemption deduction remains

HW-26 Phaseout of ExemptionsWhat is the total deduction for personal and dependency exemptions for the following taxpayers in 2007?a. Married filing jointly with two dependents and AGI of $300,000b. Single with no dependents and AGI of $200,000


HWA-26 Phaseout of Exemptions-1a. $8,704. Their exemptions before phaseout are $13,600 ($3,400 x 4).($300,000 - $234,600)/$2,500 = 26.16 (round up to 27)27 x 2 = 54% phaseout percentage 54% x $13,600 x 2/3 phaseout reduction = $4,896.$13,600 - $4,896 = $8,704


HWA-26 Phaseout of Exemptions-2b. $2,584. His exemption before phaseout is $3,400 for one personal exemption.($200,000 - $156,400)/$2,500 = 17.44 (round up to 18) 18 x 2 = 36% phaseout percentage36% x $3,400 x 2/3 phaseout reduction = $816 $3,400 - $816 = $2,584.

filing status
Filing Status
  • Taxpayer’s filing status determines standard deduction and tax rate schedule
  • Marital status determined on the last day of the tax year
    • Separated spouses are considered married until divorce becomes final
filing status married
Filing Status - Married
  • Can file jointly if both spouses are US citizens or US residents (or if nonresident alien agrees to be taxed on worldwide income)
  • If the couple files separately, both must itemize deductions or both must use the standard deduction
surviving spouse
Surviving Spouse
  • Marital status is determined at the date of death so a joint return can be filed for the year in which a spouse dies
  • A surviving spouse may continue to use the tax rates and standard deduction for married persons filing jointly for the next 2 years only if a dependent child lives with the taxpayer
filing status unmarried
Filing Status – Unmarried
  • Unmarried taxpayers file as
    • Head of household - an unmarried person who provides more than half of the cost of maintaining a home in which a qualifying child or other qualifying relative lives for more than half the year
    • Single
head of household
Head of Household
  • Claimed if taxpayer is unmarried (and not a surviving spouse)
  • Taxpayer pays more than half the cost of maintaining home which is the principal residence for more than half the year of
    • A qualifying child
    • An individual for whom the taxpayer may claim a dependency exemption
      • A parent is not required to live with the taxpayer
abandoned spouse
Abandoned Spouse
  • A taxpayer who is married but whose spouse did not live with him or her at any time during the last six months of the tax year and who provides more than half the cost of maintaining the home in which a dependent child lives
  • A qualifying abandoned spouse uses head of household tax rates and standard deduction

HW-22 Std. DeductionHarry and Silvia, a married couple, are both age 67 and legally blind. What is their standard deduction for 2007?

dependent s standard deduction
Dependent’s Standard Deduction
  • Dependent’s standard deduction is limited to the greater of:
    • $850 or
    • Earned income + $300 (up to otherwise allowable standard deduction)
    • Earned income includes salary and wages
    • Earned income does not include interest income, dividend income, capital gains, or income as beneficiary of a trust

HW-24 Dependent’s Taxable IncomeScott is 15 years old and qualifies as a dependent on his parents' tax return. In 2007 he earns $2,500 from a part-time job and also receives $800 of dividend income on stock given to him by his aunt. What is Scott’s taxable income?

itemized deductions
Itemized Deductions
  • Itemized deductions provide tax benefit only to the extent that, in total, they exceed the taxpayer’s standard deduction
  • Taxpayers can maximize use of the standard deduction and itemized deductions by timing certain deductible payments
medical expenses 1
Medical Expenses-1
  • Medical expenses paid for the taxpayer, spouse and dependents, after reduction for insurance reimbursements, are deductible only to the extent they exceed 7.5% of AGI for the year.
medical expenses 2
Medical Expenses-2
  • Qualified medical costs includes prescription drugs and insulin, costs of a hospital, clinic, doctor, dentist, eyeglasses, contract lenses, transportation for medical care and health insurance costs.
medical expenses 3
Medical Expenses-3
  • Health insurance premiums for taxpayers and their dependents are deductible only if paid from after-tax income
    • Premiums paid through an employer-sponsored cafeteria plan are not deductible
medical expenses 4
Medical Expenses-4

Premiums for disability insurance and for loss of life, limb or income are not deductible

Premiums for long-term care insurance are deductible, subject to limits based on age


HW-27 Medical Expense DeductionDaniel's AGI is $90,000. He incurred $14,000 of medical expenses and was reimbursed for $3,000 of these expenses. What is his allowable medical expense deduction if he itemizes?

  • Deductible taxes include
    • State, local, & foreign real property taxes
    • State & local personal property taxes
    • State, local, & foreign income taxes
    • Other federal, state, local, and foreign taxes incurred in a business or other income-producing activity
    • For 2005 could elect to deduct state & local general sales taxes instead of state & local income taxes
nondeductible taxes
Nondeductible Taxes
  • Federal income taxes
  • Employee's share of payroll taxes
  • Federal excise taxes not incurred for business
  • State & local sales taxes on goods for personal use
  • Assessments on property that increase property value

HW-28 Tax Benefit RuleIn 2006, Rebecca and Gregory, a married couple, filed a joint return with AGI of $70,000 and total allowable itemized deductions of $10,150, which included state income taxes paid of $3,100. They received a $900 refund of state income taxes in April 2007.How much of the state income tax refund must they include in income and in which year do they include it?


HWA-28 Tax Benefit RuleZero. Their itemized deductions of $10,150 did not exceed their standard deduction of $10,300. As there was no tax benefit derived from deducting state income taxes, none of the refund is included in income.


HWA-28 Tax Benefit RuleIf total itemized deductions had exceeded the standard deduction, then only that portion of the refund that exceeded the std deduction (up to the value of the refund) would be included in income. For example, if their total itemized deductions for 2006 had been $11,000, then $700 ($11,000 - $10,300 standard deduction) of the $900 refund would be included in income in 2007. If their itemized deductions had been $11,200 or more, then the entire $900 refund would be included in income in 2007.

interest expense
Interest Expense
  • Deductible interest includes
    • Investment interest
    • Home mortgage interest
  • No deduction for most other personal interest such as interest on auto loans, life insurance loans, credit card debt, and delinquent tax payments (except previously mentioned student loan interest)

HW-30 Interest Expense-1Pablo and Adriana, a married couple who file a joint return, purchase a $190,000 home by paying $38,000 cash down and taking a mortgage for the balance of the purchase price. The mortgage company charges them $3,000 in points for originating the loan that they pay at closing. They pay $7,000 in interest on the mortgage this year. They also purchase a new car this year for $28,000 by taking out a car loan from their credit union. They paid $975 in interest on the car loan this year. How much can Pablo and Adriana deduct for interest expense this year if they itemize their deductions?

investment int expense 1
Investment Int. Expense-1
  • Investment interest includes interest on loans to acquire or hold investment property and margin account interest paid to a broker.
investment int expense 2
Investment Int. Expense-2
  • Investment interest expense is only deductible to the extent of net investment income
    • Net investment income = excess of investment income over investment expenses
  • Excess is carried forward (indefinitely) subject to same limit in future years
investment int expense 3
Investment Int. Expense-3
  • Investment incomeincludesgross income from interest, annuities, and short-term capital gains from investment property
    • Long-term capital gains or dividends taxed at favorable rates are excluded unless election made to forgo the favorable rate.
investment int expense 4
Investment Int. Expense-4
  • Investment expenses includes safe deposit box rental fees, investment counsel fees, brokerage account maintenance fees
    • Limited to the lesser of total investment expenses or net miscellaneous itemized deductions after reduction for 2% AGI floor

HW-29 Investment Interest Expense-1Edward (single) with a 28 % marginal tax rate, incurs interest expense of $10,000 attributable to his investment in stocks and bonds. His gross investment income is $6,200 ($1,000 of which is from long-term capital gains and dividend income), and his adjusted gross income, including his investment income, is $68,000.


HW-20 Invest. Interest Exp.-2Edward incurs a $100 brokerage account maintenance fee and a $300 certified financial planner’s counseling fee. He also has $1,200 of other qualifying misc. itemized deductions.


HW-29 Investment Interest Expensea. How much can Edward deduct for miscellaneous itemized deductions?b. What are Edward’s options in determining his deduction for investment interest expense? Explain.c. What happens to the investment interest expense that he cannot deduct in the current year?


HWA-29 Invest. Interest Expensea. $240 [$100 + $300 + $1,200 – ($68,000 x 2%)] b. He can deduct $5,960 if he elects to forgo the 15% rate for his capital gain and dividend income; otherwise, he can only deduct $4,960.


HWA-29 Invest. Interest ExpenseEdward’s deduction for invest. interest expense is limited to his net invest. income, which is the excess of gross invest. income over deductible invest. expenses (excluding interest). His deductible investment expense is the lesser of the actual $400 investment expense or the allowable $250 miscellaneous expense deduction (as computed above).


HWA-29 Invest. Interest ExpenseEdward’s investment income can include long-term capital gains and dividend income only if he elects to forgo the special 15 percent tax rate that applies to that type of income. If he makes this election, his taxable income will increase by $1,000 but his tax will only increase by $130 [$1,000 x (28% - 15%)]; he will, however, be able to deduct $1,000 more in investment interest, which will save $280 ($1,000 x 28%) in taxes.


HWA-29 Invest. Interest ExpenseHis net tax savings is $150 ($280 - $130), so he should make the election. He will report investment income of $5,960 ($6,200 - $240) and investment interest expense of $5,960. If he does not make the election, he can only deduct $4,960 ($5,200 - $240) of investment interest expense.


HWA-29 Invest. Interest Expensec. The remaining $4,040 ($10,000 - $5,960) is carried forward (indefinitely) until he has sufficient net investment income in a future year.

qualified residence interest
Qualified Residence Interest
  • Interest paid for acquisition debt or home equity debt for up to 2 qualified residences
  • Interest on acquisition debt of up to $1 million principal amount (combined limit for 2 homes) is deductible
    • Acquisition debt includes mortgage to buy, construct, or improve the residence
qualified residence interest1
Qualified Residence Interest
  • Interest on up to $100,000 principal amount of home equity loan is deductible
    • Loan proceeds can be used for any purpose
qualified residence interest2
Qualified Residence Interest
  • Points (loan origination fees) paid on initial home mortgages are deductible
    • Points paid to refinance an exiting loan must be amortized over life of loan
charitable contributions
Charitable Contributions
  • Congress allows individuals, corporations, estates and trusts to deduct contributions to certain qualified organizations
  • Partnerships & S corps pass the contributions through to their partners and shareholders who then claim the deductions on their own income tax returns
charitable contributions1
Charitable Contributions
  • Qualified charitable organizations
    • Gov. units (federal, state and local govt.) and entities formed and operated exclusively for religious, charitable, scientific, literary or educational purposes, including churches, nonprofit hospitals, school and universities, libraries, and social service agencies
  • Direct contributions to needy individuals are not deductible
charitable contributions2
Charitable Contributions
  • No deduction allowed to the extent that valuable goods or services are received in return for the contribution
    • Exception - contributors to universities who receive preferred rights to purchase tickets for university athletic events may deduct 80% of the amount of their contribution.
charitable contributions3
Charitable Contributions
  • Individuals can deduct up to 50% of AGI
    • Excess contributions may be carried forward up to 5 years
charitable contributions4
Charitable Contributions
  • No deduction for contributions of the taxpayer’s services and rent-free use of the taxpayer’s property
    • Out-of-pocket costs incurred for volunteer work for a qualifying charity are deductible
  • Property other than long-term capital gain property is valued at lesser of FMV or basis
contributions of ltcg property
Contributions of LTCG Property
  • LTCG property is valued at FMV (which is usually greater than adjusted basis)
    • Tangible personalty given to a charity which does not use the property in its tax-exempt activity is valued at the lower adjusted basis
contributions of ltcg property1
Contributions of LTCG Property
  • Deduction for LTCG property valued at FMV is limited to 30% of AGI
    • 30% limit can be avoided (and 50% AGI limit applied) if taxpayer elects to use lower basis
    • If made, election applies to all LTCG contributions that year
charitable contributions5
Charitable Contributions
  • Stocks or other income producing property that have declined in value should be sold so that the loss can be claimed with the sale proceeds donated
  • Fees incurred for appraisals of donated property may be deducted as a misc. itemized deductions
  • Deduction for donated vehicles sold by charity limited to gross sales proceeds

HW-31 Charitable Contributions-1Arnold, a single individual, has adjusted gross income of $65,000 in the current year. Arnold donates the following items to his favorite qualified charities:$5,000 cash to the athletic department booster club at State University. This contribution gives him the right to purchase preferred seats to all home games. The value of this preferred right is $900.


HW-31 Charitable Contributions-2ABC stock acquired six years ago at a cost of $6,000. Its FMV at the date of contribution was $22,000.Personal clothing items purchased two years ago at a cost of $1,000. Their FMV at the date of contribution was $400.Charitable contribution in the current year?

casualty theft losses 1
Casualty & Theft Losses-1
  • Loss is the lesser of
    • Asset’s adjusted basis or
    • Decline in asset’s fair market value as a result of the casualty.
casualty theft losses 2
Casualty & Theft Losses-2
  • Loss is reduced for any insurance proceeds received
  • $100 floor applies to each casualty
  • Deductible only to extent total losses exceed 10% of AGI
  • (These limits apply only where property was not used in a business or for producing income.)
miscellaneous deductions
Miscellaneous Deductions
  • Only excess over 2% of AGI is deductible
    • Unreimbursed employee business expenses
    • Job hunting expenses (in searching for a new job in current line of business)
    • Investment-related expenses
    • Hobby expenses (up to hobby income)
    • Tax preparation and planning advice
phaseout of itemized deductions
Phaseout of Itemized Deductions
  • Total deductions phased out by 2/3 x 3% of AGI in excess of $150,500 in 2006 ($75,250 if MFS)
  • Exception - deductions not phased out for
    • Medical expenses
    • Investment interest
    • Casualty and theft losses
  • Total deductions are not reduced by more than 80% x 2/3 regardless of type